Monday, March 31, 2008

Breaking China - While the credit crisis has gotten most of the recent financial press, China's Shanghai-A Index (3-year chart above) has been steadily retracing much of its massive bull market gains. A contracting economy in China would have important ramifications for world economies (less demand for raw materials and goods) and commodities.

Quick Look at Rates - We saw more weakness in Treasury bill rates, as flight to safety continues unabated in the wake of recent Fed and central bank interventions. I see where 3-month LIBOR rates are nearly doubling the anemic 1.32% rates for 3-month T-bills. Banks continue to be risk averse in lending to one another, suggesting that added liquidity is not yet adding to confidence among institutions. Meanwhile, 10-year municipal bonds are yielding (on average) 4.05%--a 5.62% effective yield for an investor in a 28% tax bracket--vs. 10-year Treasury yields of 3.42%. Such anomalous rates--where tax-free yields are higher than taxable ones--either offer phenomenal opportunity or a frightening likelihood of municipal defaults in the wake of falling home prices and a weakening economy.

For this week's indicator review, I recalculated money flows among the Dow Industrial stocks using my own data and methodology, rather than the data from Dow Jones. My conclusion (top chart) is essentially the same: there is no evidence at this time of sustained dollar flows into stocks. Even as the market has bounced, we have stayed below the zero line, suggesting that money is flowing out of the shares of the companies that comprise the index.

We can also see (middle chart) that new 20-day highs minus lows among NASDAQ, NYSE, and ASE issues have rolled over and, as of Friday, were essentially even. This rolling over was reflected in the Cumulative NYSE TICK, which turned down on Friday after seven consecutive days of positive readings. The fact that the TICK and the new highs/lows are not plunging suggests that we're getting more of an absence of buying in the recent market than an avalanche of selling. The result has been a rather steady drift downward for much of the week.

The best one can say about the situation is that the dramatic central bank interventions have helped stopped the selling, but have not inspired sufficient confidence to sustain buying. The fact that financial shares remain market laggards does not speak well for investor confidence on the heels of those interventions.

My momentum measures have turned downward. On Friday, Demand closed the day at 38; Supply was 127. Among S&P 500 stocks, only 38% were trading above their 20-day moving averages on Friday, down from over 70% early in the week. We're seeing a bit more strength among the small caps: among the S&P 600 small cap issues, 50% are above their 20-day moving averages, down from over 75% early in the week.

Among NYSE common stocks only, we had 8 new 52-week highs on Friday and 33 new lows--the highest level of new lows of the week, but nowhere near as high as the level seen mid-month. Meanwhile, the advance-decline line for those NYSE common issues is hovering just above its bear market lows--a clear sign that broad buying has not swept the markets.

If selling does not pick up early in the week, particularly in the NYSE TICK, I would expect the market to look for a short-term bottom and enter a range mode, with last week's highs as the upper end of the range. As long as Supply exceeds Demand and stocks making new lows continue to expand, however, I will be defensive on this market. Any pickup of selling would target an important test of the mid-March lows. I will continue to update market indicators and views daily in my Twitter comments..

Sunday, March 30, 2008

As the Presidential election grinds along, candidates periodically whine about their media coverage. The truth of the matter, however, is that--for the most part--the Presidential hopefuls get a free ride on their questionable views.

Consider: Clinton and Obama can propose with straight faces (and an unquestioning media) that the U.S. government--yes, the same government that brought us emergency management in New Orleans and escalating budget deficits--will effectively and efficiently manage our health care system. McCain intones that the American occupation of Iraq--yes, the one that started as a liberation and now dangerously overstretches the military--should morph into ongoing, de facto colonization. Credulous reporters get their quotes right and pass along his prescriptions.

No, it's pretty difficult to raise media ire with matters of policy. Let there be an issue of character, however, and the media pwnage is palpable. The most recent case in point was Clinton's portrayal of herself under fire on the Bosnia tarmac. It wasn't just that she was lying; at that point she was a poser. You know the kind: the ones who show up with their Hot Topic t-shirts du jour and suddenly become alt-rockers, goths, metalheads, what have you. Liars can be engaging; posers are just annoying. And the media doesn't suffer annoying fools gladly.

That's why reporters turned on McCain when he suddenly courted the religious right and embraced the once-reviled Bush tax cuts. This wasn't the maverick everyone loved; it was a conservative poser--and the conservatives knew it most of all.

Bush the draft avoider lands his aircraft on a destroyer and declares "mission accomplished"? Poser. Romney the Massachusetts moderate discovers the evils of immigration? Spitzer the righteous solicits services from the human traffickers he prosecutes? Posers all; bring on the media feeding frenzy.

So perhaps it's a sign of the topsy-turvy times that Obama's recent fortunes hinge on the desire that the American public will actually see him as a poser in the Wright church: a likable unifier who only sat in the pews to build his street cred with Chicago constituents. The possibility that it's not a pose--that it's part of a larger, consistent pattern of sincere disaffection with the country--well, that is worse than annoying. Love of country, like love of a spouse, loses more than credibility when framed as incessant calls for change.

Will we elect a poser? Will we elect someone we desperately hope is a poser? Only in an environment where such questions are possible could the Republican who solicited partnership with John Kerry, then the endorsement of George Bush, ride the "straight talk express" to his party's nomination.

Mad props to the Camron Systems site, which linked this phenomenal article from the NY Times on the development of talent and how elite athletes are made. I'm usually not one to gush, but this is a must-read article if you're interested in developing trading talent or in designing training programs to develop trading talent. Especially interesting is the discussion of how the brain undergoes changes (myelinization) as the result of proper training.

Discussing Spartak, an elite Russian training program for tennis players, the article explains:

If Preobrazhenskaya's approach were boiled down to one word (and it frequently was), that word would be tekhnika - technique. This is enforced by iron decree: none of her students are permitted to play in a tournament for the first three years of study. It's a notion that I don't imagine would fly with American parents, but none of the Russian parents questioned it for a second. "Technique is everything," Preobrazhenskaya told me later, smacking a table with Khrushchev-like emphasis, causing me to jump and reconsider my twinkly-grandma impression of her. "If you begin playing without technique, it is big mistake. Big, big mistake!"

So there you have it: why so many traders fail. They begin trading without technique. They try to develop their trading accounts before they've done the work to develop their brains.

Technique develops brains: the implications for the development of traders are profound.

Someday, a trading firm is going to get it and become the Spartak of the financial world.

Hats off to Camron Systems for recognizing the importance of the article.

With Friday's weakness, we continue to see deterioration in the Technical Strength measure, which quantifies short-term trending behavior among individual stocks. Here's how Technical Strength is shaping up as a function of S&P 500 sector, combining the ratings from five highly weighted issues within each sector:

We once again see Financials as the weakest sector, disappointing given the recent Fed attempts at stablization. The strongest sector by far is Consumer Staples, which suggests a flight to relatively recession-resistant, defensive names. The more growth-oriented technology issues are weak.

Defensiveness appears to be the watchword of the day, with investors continuing to shun the Financials and preferring the safety of companies that sell Staples over those relying upon Discretionary spending.

Saturday, March 29, 2008

There are many ways of picking up on a stock market trend that helped identify the weakness during Friday's session. Among those that I've emphasized in recent posts, the weakness among financial issues and the persistent weakness in the NYSE TICK were two notable tells.

Another indicator worth keeping an eye on intraday is the number of advancing minus declining stocks on the NYSE ($ADD on the five-minute e-Signal chart above; bottom chart). Note how advancing stocks led decliners early in the morning, but then saw that advantage wane and then turn negative around 11 AM CT. From there, each decline in stocks added more stocks to the list of daily decliners, a sign that the market weakness was broad-based.

On another note, observe how the banking stocks ($BKX; top chart) have retraced much of their recent rally during the past several trading sessions. No doubt, Wall St. speculation regarding cutting of dividends hasn't helped. Still, if the extraordinary steps taken by the Fed were seen as taking the banks out of jeopardy, it's hard to believe we'd be seeing the current retracement. Increasingly, each day's trading is amounting to a vote of confidence in the U.S. financial system. The swings of optimism and pessimism are contributing to both intraday volatility and to the relative frequency of trend days..

At the request of several readers, I'll be using morning Twitter posts to update several market indicators that I have found useful in assessing market strength and trend. These will include:

* New Highs/Lows - I particularly like to see if we have expanding or contracting new highs or lows following a period of market strength or weakness. This often signals reversal. Similarly, bursts of new highs or lows help confirm breakouts from ranges. The recent pullback in new highs was an excellent heads up for the market weakness this past week.

* % of Stocks Above Moving Average - I like this as a longer-term momentum measure and a way to assess whether stocks are gaining or losing momentum day over day. When I see divergences, I'll note the % of stocks above their MA for different indexes, such as small caps and NASDAQ issues vs. SPX stocks. This is helpful in identifying leading and lagging sectors as well.

* Demand/Supply - This is my shorter-term proprietary measure of momentum, tracking the number of stocks closing above vs. below the volatility envelopes surrounding their short-term moving averages. All NYSE, NASDAQ, and ASE issues go into this calculation. Once again, I like to see if we get more or less momentum day over day. The Cumulative Demand/Supply numbers provide excellent overbought/oversold readings and have done a fine job of tracking intermediate-term highs and lows in the past year or two.

* Technical Strength - I track 40 S&P 500 stocks that are highly weighted within eight sectors; there are five stocks per sector. The Technical Strength measure is a quantification of trending behavior in those stocks. I categorize these numbers into uptrends, neutral trends, and downtrends and examine shifts in trend day over day.

In addition to following these indicators on a daily basis, I'll also be assembling my usual weekly review of indicators on the blog over the weekends. This is a larger picture view of the markets that guides my basic strategy for the week.

For those interested in the daily review of indicators, the last five Twitter posts appear on the blog homepage. The complete set of "tweets" can be found on my Twitter page; free subscription via RSS is available there as well. I'll continue to post links of important market themes via Twitter as well as occasional market comments and a morning review of economic reports due out and how overseas markets are trading. Thanks for your continued interest.

Friday, March 28, 2008

* Buying and Selling Sentiment on Range Days - Here's a chart of today's NYSE TICK; five minute bars and a 3-period moving average. One of the clues to a range bound market is that we'll get the moving average of the TICK oscillating around the black zero line. On the moves below the line, we end up not being able to sustain fresh price lows, and on the moves above the line, we can't sustain upside breakouts (the move around 11 AM was picture perfect: buying pressure unable to move ES to new highs for the day). The quicker we can recognize the dynamics of range days, the quicker we can adjust our expectations and be nimble in taking profits near range extremes.

* Trading Rules - While we're on the topic of generous sharing, take a look at Globetrader's excellent summary of his trading rules, complete with illustrations. Formulating rules in a structured way is a fantastic aid in controlling the trading process, rather than letting markets control you. Globetrader is one of the bloggers who truly gets it, when it comes to both trading methods and trading psychology.

Thursday, March 27, 2008

My recent post reviewed research that suggests a link between risk-taking and addictive behavior. It's not just that an "addictive personality" will take undue risks; in addition, repeated large risk taking alters the structure and function of the brain so as to sustain addictive behavior. Many traders I've worked with never had discipline problems or out-of-control behaviors until they began frequent daytrading. When you think of traders at some firms placing 100 or more trades a day--basically one every four minutes--it's difficult to imagine that such frequent and unremitting risk/reward swings *wouldn't* affect the workings of mind and brain.

What's more, as Dr. Bruce Hong notes, is that exhausting frustration tolerance and willpower on one set of tasks appears to make us less disciplined on subsequent ones. That is how bad trading often leads to further bad trading, but also can lead to poor decision-making in other facets of life.

One of my first clues that a trader might be out of control is that he/she can't take a break from trading when he/she is losing money and can't reduce his/her risk after a series of losing days. This is very similar to the drinker who cannot stop imbibing alcohol even after the point of consequences.

If you are losing money and cannot stop yourself from trading--during a single trading day or after days of loss--I encourage you to take the hard look in the mirror at what you might be doing to your trading account, your emotions, your brain, your relationships, and your life.

Wednesday, March 26, 2008

I received an eloquent email from an excellent trader who marveled that he trades very well when he trades moderate (but still significant) size, but then trades quite poorly when he trades his maximum size. His level of risk-taking, he finds, affects his emotional experience in trading. Yesterday, when he traded moderate risk through the day, he traded consistently and made significant profits. Last week, when he maximized his risk, he violated a number of his trading rules and lost significant money.

Same trader, same trading methods--only risk levels altered his emotions, his decision-making, and his performance.

Research suggests that different areas of the brain process risk and reward. Moreover, brain activation in the face of reward tends to be more rapid than in the face of risk. Other research shows that individual differences in our patterns of brain activity are closely correlated to our risk tolerance and risk aversion. This research finds that "reward centers" in the brain become more or less active depending upon how much money can be won or lost. Significantly, these reward centers are "some of the same areas of the brain that are activated when people take cocaine, eat chocolate or look at a beautiful face."

There is a very important lesson to be learned from the trader who wrote to me: By controlling our exposure to risk and reward, we control the degree to which our brains get hijacked. Trading 100% of our risk turns planned trading into gambling; cutting risk back moderates the reactivity of our dopamine systems.

By creating the right kinds of experience, we literally can shape our brains for success. By generating the wrong kinds of experience, we can turn ourselves into impaired decision-makers. The difference between right and wrong, for traders, often boils down to the amount of risk we take with the capital we have.

I try to avoid overstatement, but in my opinion, this is one of the most important topics I've ever posted to the blog. Those who read the research linked above and the posts linked below--and who heed the message of risk levels and brain function--quite literally can save their trading careers and meaningfully advance their odds of success. You can't succeed if you don't have control, and you don't have control if the reward circuitry of your brain is hijacked by the risks and rewards you're pursuing.

Tuesday, March 25, 2008

A number of readers have asked me recently about tracking program trading. Program trading refers to trades in which stocks are purchased or sold in baskets either for arbitrage or for placing directional bets on sectors, themes, or the broad market. Because the Dow Jones Industrial stocks are among the market's most liquid issues, they are commonly included in baskets by institutional traders. When we see the great majority of Dow issues uptick or downtick simultaneously--giving us extreme high or low Dow TICK ($TICKI) readings--we can infer the presence of program trading. Executing the trades in the shares at the same time creates the sudden rise or drop of $TICKI to very high or low levels.

The top chart shows the first hour of trading in the June ES futures from today's market. The bottom chart shows the one-minute candlesticks for $TICKI, with a 3-minute moving average (blue line) oscillating around the neutral, zero level. The one-minute bars pretty much look like noise, but we can see from the moving average that we started the day with a distinctly negative skew to $TICKI, even as the market rallied in the opening minutes. In other words, programs were selling into the rally.

The blue line stayed mostly below the zero point as the market declined, until buy programs jumped in shortly before 9 AM CT. The market bottomed shortly thereafter and further buy programs led the ES futures higher.

Because program trades can be executed for arbitrage rather than as part of directional bets, not all rises and declines in $TICKI reflect net institutional buying or selling. Hence it's important to see how the TICK for the broad market ($TICK) and price behave when we register $TICKI extremes. It is not uncommon, as in the example above, for shifts in program trading to lead short-term turns in the stock indexes.

* Strong Market - Monday was a strong day, with my Demand measure (index of stocks closing above the volatility envelopes surrounding their short-term moving averages) hitting 204 and Supply (index of stocks closing below their envelopes) falling to 18. That means that stocks with significant upside momentum outnumbered those with significant downside momentum by more than 10:1. It is common to see short-term follow-through price strength following such momentum. Note that my Adjusted Cumulative Demand/Supply Index (chart above) is nearing the +20 (overbought) level that has corresponded to subnormal 20-day prospective returns in SPY. Note that new 20 day highs among NASDAQ, NYSE, and ASE stocks rose to 1041 and new 20 day lows fell to 418 on Monday. That is the highest level of new highs since the end of February. I continue to lean to the long side while Demand exceeds Supply and new highs are expanding.

* Themes for the Current Market - Once again, an excellent summary of the themes out there from Abnormal Returns, including problems in the commercial paper market and a very thoughtful post about debt, external default, and inflation. This is the kind of material that's worth reading if you're looking to *understand* markets and their interconnections. See also some juicy links from Chris Perruna, including a very interesting (and accurate, IMO) look at what kinds of trading returns are impressive over a period of time.

* Great Advice - Insightful post from A Dash of Insight highlights the importance of figuring out what markets (and regulators) are *going* to do, not getting caught up in your opinions of what they *should* do. So much of what you read out there are editorials, not market analyses. .

Monday, March 24, 2008

I'm pretty much going to let the above annotated chart of today's ES futures (click for greater detail) speak for itself. Notice how we began the day with strong buying volume, which then tailed off as the morning wore on, which led to sector non-confirmations at the late morning price highs, and which led sellers to press their advantage early in the afternoon.

Volume, TICK, price, the action of various sectors--all of these things are interrelated and tell a story.

So much opportunity is lost when traders become tunnel visioned, seeing only the market they are trading, focusing only on price.

It's about the ebb and flow of supply and demand, and only an expanded field of vision can capture those shifts.

Anxiety, frustration, greed: these narrow our field of vision. It's when we let markets speak to us that we can best appreciate their patterns. It's difficult to truly see the markets, however, when we're filling our heads with images of success and failure.

Today's market is notable thus far in that we're seeing solid buying sentiment (NYSE TICK) and very positive money flows accompanying a multi-week upside breakout in price (see chart above). The context for this was set when we made the new bear market price lows last week, with significantly fewer NYSE common stocks making fresh 52-week lows than in January.

We need to stay above the breakout line level to sustain the intermediate-term uptrend. Given that, the next very important test of resistance would be the February price highs. .

Notice the distribution of the NYSE TICK early this AM. We have been solidly above the zero line, indicating that the vast majority of NYSE issues have been trading at their offer rather than bid price. That's a clear indication of bullish sentiment among large market participants.

If you had been sitting by my side at 8:34 AM CT, just four minutes into the session, you would have heard me exclaim, "Holy Shit!" The reason was that we had a couple of sell programs hit the market and the TICK could not even hit zero. (We got as low as +210). That suggested very solid buying interest out of the gate. Given that we were near multi-week resistance (per the recent post), it suggested to me that: a) we would test that resistance; and b) we had a good shot at breaking it.

Reading these patterns of short-term buying and selling interest early in the session can help you frame hypotheses regarding market action that form the basis for solid trading ideas. Had I not been very familiar with TICK patterns within the first five minutes of trading, however, the idea and the trade would not have been possible. This is where screen time and the internalization of those market patterns become all-important. No amount of trading psychology can substitute for that kind of preparation..

Back on March 7th, I began noticing a drying up of stocks making fresh bear market lows relative to January, noting some cracks in the foundation of the bear market. These divergences were also apparent in my last indicator review, which was waiting for stabilization among the financial stocks before aggressively taking the long side. The market did give us fresh price lows on Monday of this past week, but once again the divergences relative to January were present. With increasing Fed activism, those financial stocks rallied for the remainder of the week, posting a three-week closing high in the banking index ($BKX). Moreover, the same is true of the housing sector index ($HGX), which managed to hold above its price lows from January. As I write, the ES futures are knocking on the door of important three-week resistance around 1345 in the June contract. Are those financials leading the broad market higher?

Let's see what the indicators are saying:

New Highs/Lows - We can see from the top chart that, despite vigorous buying in the sectors hit hardest by the recent selling, new 20-day highs continue to lag new lows. Indeed, even with Thursday's price strength, we had 608 stocks across the NYSE, NASDAQ, and ASE make fresh 20-day new highs against 1391 new lows. This suggests that, at least so far, the buying is selective and not lifting the broad list of stocks significantly. We will need to see expanded new high strength--and certainly greatly diminished new lows--before we can conclude that the recent bounce is anything more than short covering. With 18 new 52-week highs and 73 new lows among NYSE common stocks on Thursday, we also saw an expansion of new lows, but we are well off the 300+ new lows registered on Monday.

Composite Money Flow - In the bottom chart, I combined the raw money flows across the 40 stocks from the eight S&P 500 sectors that I reviewed, so that we could see how total five-day money flows have been running vis a vis SPY. What we can see is that total money flow has been running below the zero line for the most part and is negative at present. This supports what we're seeing with the new high/low data: despite the recent price bounce, we're not yet seeing large influxes of funds into equities. I will be watching this indicator, along with the new highs/lows, on any test of the above-mentioned multi-week resistance in ES to handicap the odds of upside breakout vs. reversal. That's an issue that has important implications for the bear market and its longevity.

Advance-Decline Lines - The Advance-Decline Lines specific to the NYSE common stocks, SPX stocks, S&P 600 small caps, and NASDAQ 100 issues all made new lows last week and are only modestly hovering above those lows. The AD Lines specific to the eight S&P 500 sectors reviewed this past weekend for money flows also are near their bear lows; none is yet showing sustained strength.

I will post a separate analysis of the Cumulative NYSE TICK later this week. Suffice it to say that the TICK supports the findings from the three sets of indicators above: only tepid strength coming off the recent price lows. I need to see greater evidence of sustained buying interest before concluding that we've seen a turn in the recent bear market..

Sunday, March 23, 2008

This is the last of eight S&P 500 sectors that I'm reviewing for money flows. The recent posts in the series include Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, Healthcare, and Financial stocks. Here we're examining five highly weighted Technology issues, with Cumulative Money Flow (top chart) and Five-Day Average Flows (bottom chart) plotted against the XLK (Technology) ETF. The five stocks included in the calculations are MSFT, INTC, IBM, CSCO, and VZ.

We can see that the Technology sector, like Financials and Healthcare, has shown recent relative weakness, breaking below its January price lows. Nevertheless, we haven't seen new lows in Cumulative Money Flow, suggesting some drying up of selling during the recent decline.

The lessened selling, however, has not translated into aggressive buying. We are only modestly off the recent price lows, and five-day money flows have remained negative. As with so many of the other sectors, we've yet to see sustained buying interest that would lead us to expect a major change of trend..

My recent posts on Money Flows have focused on the Materials, Industrials, Consumer Discretionary, Consumer Staples, Energy, and Healthcare sectors. This post examines five highly weighted issues within the Financial stock sector, tracking Cumulative Money Flow (top chart) and Five-Day average flows (bottom chart) against the XLF (Financial) ETF. The stocks included in the calculations are C, AIG, BAC, WFC, and JPM.

Like the Healthcare issues, Financials have shown recent weakness, breaking below their January lows during the latest market leg down. Observe, however, that we did not see a new low in Cumulative Money Flow, suggesting a possible drying up of selling pressure.

We've since bounced nicely off the latest lows on news of Fed intervention, but note that five-day money flows have stayed weak on the bounce. Much of market skittishness concerns the troubled financial sector; sustained dollar inflows would suggest a renewal of confidence among investors. Thus far, however, though we have seen less intense selling pressure on declines, we're not yet seeing sustained buying interest on bounces. I will be watching flows in this sector particularly closely given this dynamic..

Previous posts in this series have examined money flows in the Materials, Industrials, Consumer Discretionary, Consumer Staples, and Energy sectors. Here we're examining five highly weighted stocks from the healthcare sector, with Cumulative Money Flow (top chart) and Five-Day Flows (bottom chart) plotted against the Healthcare ETF, XLV. The stocks included in the analysis are PFE, JNJ, MRK, LLY, and AMGN.

Note that, unlike many of the other sectors, Healthcare shares have been quite weak during the recent market decline, dropping to new bear market lows. This weakness was preceded by steady dollar outflows from the sector: note the steady downtrend in Cumulative Money Flow. Not only is the sector weak; there are no signs at present of a sustained flow of funds into these shares.

Five-day flows have bounced a bit, but remain negative. Note how positive periods of five-day flow have not been sustained, often leading to subsequent price weakness. Of the sectors, this is one that is relatively weak, both in price performance and money flows..

In my recent posts, we've explored money flows into the Materials, Industrials, Consumer Discretionary, and Consumer Staples sectors. Now it's the turn of the Energy stocks. Above we see the Cumulative and Five-Day Flows for five highly weighted stocks within the sector, plotted against the Energy ETF, XLE. The five stocks included in the analysis are XOM, CVX, COP, SLB, and OXY.

What we see off the bat is that Energy issues have been relatively stronger than other sectors, thanks to commodity strength. Indeed, their chart looks more like the chart for the Materials sector than most of the others for this reason. Note also that the recent market weakness failed to bring XLE below its January lows. This non-confirmation, which we've observed among the other sectors as well, has played an important role in the market's very recent bounce.

That having been said, we did not see a bounce in XLE late last week, owing to the commodity selloff. Moreover, Cumulative Money Flow for the Energy stocks has been in a steady downtrend since August, 2007. Considering the historic strength in oil prices over this period, XLE performance has been muted. Indeed, it appears that money has been systematically coming out of this sector over time.

The five-day flows show that particularly little capital flowed into the sector during the bounce from the January lows. That has set up the current weakness. While the sector is range bound and the non-confirmation of the January lows was encouraging, there is not yet evidence of significant funds flowing into energy issues that would power an upside breakout..

A pattern that we saw with the three sectors mentioned above is also apparent here: during recent market weakness, XLP failed to break below its January price lows. Note, however, that during the recent weakness, cumulative money flows for the Consumer Staples shares have been in a steady downtrend, testing bear lows. This is quite different from the flow patterns seen among the Materials and Consumer Discretionary shares, which showed reduced selling pressure during recent market declines.

Five-day flows remain weak despite a recent bounce in the sector. Clearly, despite the ability to hold the January lows, we're not seeing sustained buying interest among the Staples..

My last two posts tracked money flows for the Industrials stocks and for the Materials shares within the S&P 500 universe. This post takes a look at five highly weighted Consumer Discretionary stocks and plots their cumulative money flow (top chart) and five-day average flows (bottom chart) against the Consumer Discretionary ETF, XLY.

Note that, like the Industrials and Materials sectors, the Consumer Discretionary stocks have thus far held above their January lows. Observe also that cumulative money flows have held up quite well during the period of recent market (and sector) weakness, as we remain well off the money flow lows from late 2007.

Five-day flows have turned negative for the sector, but are nowhere near as intense in selling pressure as those from late 2007. While we have yet to see sustained buying interest among these shares, there does appear to be a drying up of selling pressure thus far..

In my most recent post, I tracked the money flows in the Materials sector of the S&P 500 stock universe. Above we see the cumulative raw money flows (top chart) and five-day average flows (bottom chart) for five highly weighted industrial stocks. These are plotted against the Industrials sector ETF, XLI. The five stocks included in the calculations are GE, UPS, BA, UTX, and MMM.

Note that the flow patterns for the Industrials sector look very different from those seen among the Materials stocks. Cumulative flows have been in a steady downtrend (Friday's strength notwithstanding), indicating a flight of funds from these issues.

Five day flows are currently positive--something we haven't seen often since August, 2007--and the sector index has so far held above its price lows from January. We'll need to see sustained buying (positive flow figures), however, to conclude that the recent bounce is anything more than short covering..

In this series of posts, I ask the question, "Where's the Flow? (WTF)" for eight major sectors within the S&P 500 large cap universe.

Here I chart cumulative daily money flows (raw values; top chart) and a five-day moving average of money flow for five highly weighted stocks within the S&P 500 Materials sector. The money flow lines are plotted against the Materials ETF, XLB. The stocks included in the calculations are DD, DOW, AA, IP, and WY.

Note that five-day flows have oscillated around the zero level and tracked price reasonably well since August, 2007. We're neither seeing meaningful deterioration in money flows in this sector, nor seeing major accumulation of shares. Interestingly, we had a selloff in Materials stocks on Friday with the broad decline among commodities, but money flows were not negative on the day. This appears to be part of a broader pattern in which we're seeing higher lows in the cumulative money flow line (top chart). This may be suggesting a drying up of selling pressure within the sector.

In general, we've seen the best short-term buying opportunities in this sector when five-day flows have been negative. We are modestly positive at present. A break of the cumulative flow line above zero would suggest increased accumulation of these shares.

Here's a weekly chart going back to the 2000 lows in the municipal bond market. We're looking at Vanguard's Intermediate-Term Tax-Exempt Fund (VWITX). According to the Vanguard site, the fund is currently yielding 3.67% on bonds with an average maturity of 7.1 years. About 87% of the holdings are rated AAA or AA. When we compare the tax-free yield of 3.67% with the yields offered on taxable certificates of deposit, the muni rate is quite attractive. Nationally, we're seeing average 5 year CD rates of 3.29%, according to Bankrate.

So what we have is one of two things:

1) A pricing anomaly that is a reflection of overblown fears of municipality vulnerability and monoline insurance fragility;

When muni rates for VWITX rose over 4% earlier this month, we saw investors snap up the attractive yields. A similar pattern occurred across the other funds I investigated. We remain well above the price lows from early March, though yields remain historically high relative to those available from Treasuries. By way of comparison, the Vanguard Intermediate Term Treasury Fund (VFITX) averages a maturity of six years and is currently yielding 2.79%.

The risk premium built into the munis is also evident among other bonds. For as close to an apples-to-apples comparison, I took a look at Vanguard's Intermediate-Term Investment-Grade Fund (VFICX). It has an average maturity of 7.8 years and over three-quarters of its holdings rated A or above. The most recent posted yield is 4.97%--again notably higher than the yields on Treasuries or bank CDs. It's interesting to note that VFICX is also trading above its recent lows, as yields over 5% found investor interest.

We saw harrowing declines in both munis (VWITX) and investment grade bonds (VFICX) in 2000, reflecting similar fears of default. Those bond markets recovered sharply well in advance of the stock market lows, reflecting reduced fears in the face of Fed easing. We're now getting significant Fed easing and bonds are off their highest yields. That has me looking for evidence of continued confidence among bond investors to see if the Fed's ministrations can help these markets turn the corner now as they did in 2000.

In that sense, these bond markets are excellent sentiment gauges. If the Fed's actions bring stability and confidence to the financial system, these yields should be very attractive and attract continued buying. If, however, we see sustained risk premia and even worsening bond prices in the face of aggressive Fed actions, then we have to look at the real possibility that these are not pricing anomalies and, instead, reflect anticipations of much worse things to come for debt issuers.

Friday, March 21, 2008

The chart above tracks a five-day moving average of money flow across the Dow 30 Industrial stocks. Money flow is a measure of the dollar volume of trades on upticks minus the dollar volume of trades on downticks. The result shows the amount of funds flowing in and out of the market. Please note that these are raw money flow figures, not ones adjusted with respect to market volume or compared with a moving average period.

The money flow aggregated across the 30 Dow stocks correlates highly with price change for the Dow average as a whole--about .44 over the time period covered by the chart--but it is an imperfect relationship. It's when we see money flowing out of the market even during periods of price strength--and money flowing into the market during times of price weakness--that the data are most helpful. When the market peaked late in February, for example, dollar flow readings for the Dow stocks were consistently negative.

Our chart tells us two important things:

1) Money has been coming out of the market, as measured by the Dow. A cumulative line of the money flow data has a steady, negative slope.

2) Five-day peaks in money flow have tended to correspond with intermediate-term tops in the Dow during this declining period of stock prices.

Most recently, the Dow has bounced off its lows and five-day money flows have just turned positive. There is nothing yet in the readings to suggest that large amounts of funds are flowing into stocks. Rather, recent money flows into Dow stocks have been subdued, and that has me questioning the longevity and sustainability of the recent bounce.

Back in the day, I used to meet with a number of couples in counseling. Not infrequently, infidelity was a major issue bringing them to see me. In a surprising number of cases, the signs of infidelity were present long before the affair was caught. Indeed, many times there were explicit warnings from others who saw what was going on. Still, the spouse didn't want to believe the worst...made excuses...turned the other way...until evasion was no longer possible.

Denial is a powerful human motivation. We have a drive to know the world around us; less commonly appreciated is our capacity to sustain ignorance. Many times, we just don't want to know the truth, whether it's what happens in a military prison or what keeps our spouse out so late.

One particularly uncomfortable truth for traders is that their lack of profits is simply due to trading randomness. It's not a lack of discipline, a lack of trade planning, or a lack of tweaking the right indicators that create losses--all of those are relatively easy to address. No, losses are caused by trading strategies that simply do not work, and that's not so easily remedied.

It's pretty threatening to think that what you're devoting time and money to has no grounding in reality. It's much easier to simply not think about it. Like the spouse who manufactures one excuse after another in the face of a partner's erratic behavior, we construct all sorts of explanations for our shortcomings.

Or we just put the blinders on. When I started working with traders some years back, I asked them to indicate their profitability over the past year. I was shocked that most could not give me (or would not give me) a response other than a hesitant, "I'm coming close to break even." Many had simply stopped looking at their account statements. The idea of actually drilling down into their trade data and extracting information about what they were doing right and wrong was quite threatening for them.

Sadly, there are plenty of willing accomplices in this denial. Coaches eagerly assure you that "psychology" is the difference between winning and losing in markets; gurus promise you hidden market secrets that will enable you to unlock your potential; publishers crank out books on how you can succeed at trading. But no one solicits trading magazine articles, workshop presentations, or books on the topic of *lack* of edge. No one wants to hear all the first-hand stories I can tell about lives and relationships harmed and even destroyed by false hopes and promises.

That's too uncomfortable. No one can make money from it. So we don't look at it; we choose to not know. But I'm telling you truthfully: I've seen just as many lives hurt or ruined by trading as enhanced.

A while back, I was asked to submit a proposal for a workshop hosted by one of the major financial exchanges. I thought a real public service would be to present research and first-hand observations pertaining to addictive patterns among day traders: how to recognize trading addiction, and what to do about it.

The idea was shot down immediately. As it turns out, it wasn't the conference coordinator that pulled the plug, but the corporate sponsor of the event. Sponsors don't make money when people don't trade or when they trade in a more controlled fashion. People, after all, come to hear about trading as a dream, not as a nightmare.

A little while back a trader begged me to talk with him over the phone and help him with his "self-defeating" emotional patterns. In an unguarded moment, I agreed. He told me about his anger and frustration during trading and how those had led him to violate his risk management rules.

I asked the trader to give me examples of what was going on during these periods of frustration. Many of the occasions boiled down to times when he was profitable on trades, but then saw those profits reverse. I drilled down further to get examples of those trades and discovered that, even though he called himself a daytrader, many of his reversals occurred on positions held overnight. Indeed, he proudly told me his rule that limited his overnight exposure to only his most profitable daytrades.

A bit skeptical, I asked him what he based the rule on. How did he know that profitable positions intraday would become further profitable if held into the next day?

He seemed stunned that I asked. I guess we're all supposed to know that "the trend is your friend" and that you should always trade with the trend.

I quickly got on the computer, downloaded daily open-high-low-close data for the S&P 500 Index (SPY) going back a little over a year (to the start of 2007) and threw together a spreadsheet that looked at returns following up days and down days. There was no programming or advanced Excel techniques to what I did; it took all of a few minutes.

To recreate what I found: When SPY was up on the day (N = 159 trading days), the next day's open averaged a loss of -.02% (79 up, 80 down). Similarly, when SPY was up on the day, the next full trading day averaged a loss of -.13% (75 up, 84 down).

When SPY was down on the day (N = 146), the next day's open averaged a gain of .03% (86 up, 60 down). When SPY was down for the day, the next trading session as a whole averaged a gain of .11% (85 up, 61 down).

So, in other words, the trader's rule had absolutely no grounding in reality. If anything, he would have been better off fading the prior day's direction. He was becoming frustrated and angry because he was losing his profits. He was losing his profits because he was trading a setup that had no validity. Frustration wasn't causing his trading problems; his bad trading was generating (understandable) frustration.

But, for me, the eye-opener was that he had never thought to check out his rule. Even if he didn't want to crack an Excel primer and learn how to find answers for himself, he could have simply kept records of his overnight trades vs. his intraday trades and seen what was working and what wasn't.

But he didn't do that.

That's when it hit me: He didn't *want* to know.

My caller was not happy with my analysis and did not seek me out further. I didn't deliver what he wanted. He wanted a self-help psychological technique to keep him disciplined, so that his rules would make him money. He didn't want someone pointing out that his rules were invalid and that following invalid rules with discipline will simply lead to ruthless consistency in drawdowns.

As our conversation wound down, he defensively explained that he had plenty of other patterns that he traded that were valid. One of his favorites were opening gaps. Long story short, I examined the spreadsheet and told him that this, too, was coming up blank. To recapitulate, upside opening gaps led to 83 wins and 82 losses for the coming trading day; downside gaps led to 71 wins and 69 losses. There were no significant differences in the sizes of winners and losers. There was no edge there at all.

"But that's for the S&P," he said. "The gaps work for the stocks."

"Which stock would you like me to run the data on?", I asked. He said no thanks; he didn't need the data.

But the analysis wasn't the point. The point was that he was trading a belief in an edge, not an edge that he had independently validated. His entire trading strategy rested on (blind) trust in these patterns. He didn't *want* to know if the patterns were good, because that--like the spouse's actual discovery of an affair--would necessitate facing unpleasant realities and making difficult changes.

I recently started work with a trader who wrote to me in elaborate detail of recent trading losses. He immediately offered to share his account statements with me so that I could help him change what he was doing. No denial. No defensiveness. No willing blindness. Just an open kimono. I confidently predict that this trader will be successful. He's doing the hard work right now: he's facing shortcomings with eyes wide open. By owning what's worst with his trading, he'll discover the best within him.

Thursday, March 20, 2008

In my recent post, I suggested that the relationship between the NYSE TICK and the Market Delta for a broad index provides a multidimensional view of short-term sentiment. If you click on the chart above, you'll see a nice setup from this morning's trade. The ES volume at bid vs. offer is within each of the bars in the Market Delta chart. The five-minute high and low values for NYSE TICK are in black beneath each bar.

Note how the NYSE TICK actually started drying up on the breakout move, ahead of price and Market Delta. That was an early clue that a large number of stocks weren't participating in the upmove. (Energy and materials stocks, among others, failed to confirm the highs). Once we made the new price highs at the top of the day's range, however, note how volume at offer vs. bid and NYSE TICK dried up. That provided plenty of advance warning for the retracement back into the recent range.

These transitional patterns play themselves out on multiple time frames and can be found just about every trading day.

My most recent research has led me to investigate the relationship between the NYSE TICK and the Market Delta readings for a given period of time. We can think of TICK as capturing the breadth of sentiment: it tracks how many stocks are trading at their offer price vs. their bids. Market Delta, on the other hand, tracks what we might call the *depth* of sentiment: the intensity of buying (volume at offer) vs. selling (volume at bid) for any given instrument.

What I'm finding is that the relationship between the two provides useful information that is not apparent from either one by itself. For example, when we have dominant selling in the ES futures that is not matched by particularly negative NYSE TICK, this selling tends to be reversed. Conversely, trending markets tend to see the two measures traveling in unison.

From a statistical vantage point, the operative question is: What is the expectable value of NYSE TICK for a given Delta reading in ES (and vice versa)? When is the relationship between breadth and depth of buying/selling behaving normally, and when is it out of whack?

It appears to be the out-of-whack occasions that provide the most valuable signals. More to come.

* Choppy Action - I took a look at the trajectory of my Cumulative Demand/Supply Indicator after today's trade. Continued choppy action with lack of follow-through on rises would lead to an *overbought* condition at a much lower price level (than the prior overbought signal), and that would trigger a major sell signal for my intermediate-term trading. We're not there yet, but the concern is on the radar..

* Tracking the Rally - We swung to very positive momentum on Tuesday, with my measure of Demand at 202 and Supply at 13. This means that about 16 stocks closed above their volatility envelopes for every one that closed below. Such extreme readings usually lead to follow through on the upside on a short-term basis. New 20-day highs across the NYSE, AMEX, and NASDAQ expanded to 479; new 20 day lows dropped to 943. My Technical Strength measure showed trend shifts across many of the 40 stocks that I track across eight SPX sectors. Specifically, we're now seeing 21 stocks in uptrends, 7 neutral, and 12 in downtrends. We're now seeing 53% of SPX stocks trading above their 20-day moving averages, up from just 17% on Monday. Following relative strength and weakness among the financial issues has worked well. If this rally is for real, we should see follow-through buying in this sector.

Tuesday, March 18, 2008

Here are some of the common issues that I'm hearing from traders during recent coaching sessions. Most of us can recognize ourselves in one or more of these patterns:1) Becoming Overly Focused on P/L During Trading - Watching your profits or losses tick up and down during a trade; becoming anxious about P/L and letting P/L, not a trading plan, dictate when you get out of a trade. It's a recipe for performance anxiety. By focusing on process goals rather than P/L, you can stay grounded in good trading practices and minimize performance stresses.

2) Trading Much Larger After a Series of Winning Trades - It is common that traders become overconfident after a series of wins and decide to increase their risk by a factor of two or more. This often leads to large losing trades that wipe out much of the profit, generating frustation and discouragement. Just as it doesn't make sense to plow into a trade after a large move has already occurred, it doesn't make sense to plow into risk after a series of profitable trades.

3) Failing to Learn From Losing Trades - Traders often want to put losses behind them and not dwell on negatives. The downside is that they don't learn from their losses and thus miss opportunities to understand what's happening in markets and what they might be doing wrong. This is especially important following a series of losing trades: either you're not seeing the markets well, or you're not acting well on your perceptions. Both scenarios offer learning opportunities that can help generate profits down the line.

It's common to think of trading as a stressful occupation, but much of the stress is self-generated. By staying focused on "best practices" in trading, we minimize fear and frustration and build confidence in our development.

In my recent post on how much coaching is enough to produce change, I summarized research from the dose-effect research literature. One problem with this is that the literature is primarily oriented to clinical populations: those with diagnosable disorders. Fortunately, there is one setting for applied psychology that focuses more on normal, developmental problems than clinical ones: college counseling centers.

Having worked at a college counseling center at Cornell University and then directed a student counseling service at SUNY Upstate Medical University, I can attest to the similarities between work with students in higher education and coaching of professionals in trading and other fields. In my work at Syracuse, fully two-thirds of the people seeking assistance were looking for help with such normal concerns as relationship problems, career issues, and performance-related stress. Interestingly, these are also among the most common issues that traders discuss with me. Many of the same cognitive, behavioral, and solution-focused methods that are helpful in work with students are also relevant and useful for traders.

So what can college counseling teach us about the coaching of traders? A very interesting research study conducted in 2000 summarized college counseling work with almost 1700 students across over 40 campuses. This provides a broad cross-section of schools and students. The study found that over 1000 of the students--about 60% of the sample--only attended 3 or fewer counseling visits. This is not unusual: other studies of utilization of helping services have found that the modal number of visits to a psychologist or counselor is one.

The low number of visits does not necessarily mean that the services were not helpful. Rather, the study found that almost 30% of the students reported significant improvement by the end of one session and nearly 40% by the end of the third visit. Among those who attended 10 sessions, 54.5 % reported significant improvement. The study authors suggest that this shows a dose-effect relationship among the college students: more visits produce better results. It also suggests that about half of all people in the college setting--which I believe is the best mirror for coaching settings--can benefit from short-term help. Indeed, they often vote with their feet and only attend several helping meetings.

Still, the data suggest that many people do not benefit from short-term help. On college campuses, this can include people with ongoing problems with anxiety, depression, eating disorders, and substance abuse. Similar problems can be found among traders. Of the people who attended 10 sessions, 9.1% actually deteriorated over time and 36.4% reported no change. This is a finding that is not frequently discussed among psychologists and counselors, and certainly not among coaches: some people get worse, despite best efforts at helping. This may be due to a lack of skill among helpers; a poor personality fit between helper and client; or an unusual problem that is not detected by the counselor.

My experience is that the latter is most often the case. I have met with traders who have received prior coaching (and sometimes therapy), only to find that they have a diagnosable problem that went unrecognized. Sometimes the problem is depression; sometimes it is a form of anxiety; sometimes it is an eating disorder; and sometimes it is a purely medical problem that manifests itself as emotional distress (e.g., a thyroid disorder). It is also sometimes the case that a problem is longstanding and severe and simply needs more than 10 sessions of assistance. One research study, for example, found that individuals with severe emotional disorders continue to show therapeutic responses for 25 sessions of therapy and more.

So what can we conclude from this research? Simple performance problems--especially those that are relatively recent and not severe--often require only short-term assistance. In such cases, coaching can be targeted and brief. Longer-standing problems and those that are affecting multiple areas of life--not just trading--often take more than a brief course of assistance. Generally they require a comprehensive assessment from a trained professional. Coaching holds much promise for many people, but extrapolations from the college counseling research suggest that about half of all people will not benefit from it. That's something you won't hear from helpers eager to collect your fees, but it's important for you to know if you're contemplating help.

Monday, March 17, 2008

Here's an example of a great setup from this morning's trade. It's an example of how I think about morning trading, which may be useful for some readers.

My trade idea usually begins with a "reference range". This can be the overnight range (as in the example above) or the range from the previous day's trade. As the current day unfolds, I look at several indicators to handicap the odds of either breaking out of this range or returning toward the range midpoint when we're near a range extreme:

1) NYSE TICK - I look not only at the raw values of the TICK (which indicate how many stocks are trading at their offer vs. bid price), but how the distribution of these values is shifting over time and how the values are impacting price. What was unusual in today's trade is that we started the day with negative TICK values, but could not make new price lows relative to the overnight range. This told me that selling pressure could not move the market lower and bolstered my expectation that we'd return toward the midpoint of the overnight range. As the early morning progressed, we saw an upward distribution in the NYSE TICK values (rising moving average of TICK), which indicated increased buying interest.

2) ES Volume at Bid/Offer - I read this from a Market Delta screen, and it complements the NYSE TICK quite well. In this case, it showed buyers in size lifting offers in the ES futures, even as the NYSE TICK was still giving negative readings. This suggested to me that large traders in the futures were using the downside opening gap to buy value, again leading to an expectation of a return toward the range midpoint.

3) Leading Sectors - The major leading sector for the recent market has been the financial stocks. When I saw C, GS, and LEH catch a bid in early trade, I expected the broad market to follow suit, against suggesting a return toward the range midpoint.

Because the overnight range was so large, the setup led to a nice move and gain. I was in the trade at 8:40 AM CT (bought SPY) and exited at 9:30 AM CT once we stalled near my price target.

By organizing your perception in terms of ranges and then tracking how stocks are behaving at the edges of those ranges, it's possible to anticipate breakout moves and reversion moves back into the range. A majority of my trades follow this logic.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.